©2002 South-Western College Publishing Chapter 9 Monopoly Key Concepts Summary Practice Quiz Internet Exercises ©2002 South-Western College Publishing

What is a monopoly? Single seller Unique product Impossible entry into the market

What are the most common monopolies? Local monopolies are more common real-world approximations of the model than national or world market monopolies

What does it mean to have a unique product? There are no close substitutes for the monopolists product

What are some examples of impossible entry? Owner of a vital resource Legal barriers Economies of scale

What is a natural monopoly? An industry in which the long-run average cost of production declines throughout the entire market

What is unique about a natural monopoly? A single firm will produce output at a lower per-unit cost than two or more firms in the industry

What is a price maker? A firm that faces a downward-sloping demand curve

What is the difference between monopoly and perfect competition? The D and MR curves of the monopolist are downward sloping; in perfect competition they are horizontal

What is unique about the demand curve for a monopolist? The monopolist demand curve and the industry demand curve are one in the same

Minimizing Costs in a Natural Monopoly Cost per Unit (dollars) 40 35 30 25 5 firms Cost per Unit (dollars) 20 2 firms 15 1 firm 10 5 Quantity of Output 100 20 40 60 80

What determines price for a monopolist? Demand

Why is MR < P for all but the first unit of output? To sell additional units, the price has to be lowered; this price-cut applies to all units, not just the last unit

Price & Marginal Revenue $100 Monopoly $75 Demand $50 $25 Price & Marginal Revenue $-25 $-50 Marginal Revenue $-75 $-100 Q 2 4 6 8 10 12 14 16 18

Monopoly $400 $300 Total Revenue $200 $100 Q 2 4 6 8 10 12 14 16 18

Where does a monopolist produce to maximize profit or minimize losses? MR = MC

P D Q Profit MC ATC AVC MR MR=MC 1 2 3 4 5 6 7 8 9 $200 $175 $150 $125 $100 Profit $75 AVC $50 D $25 MR Q 1 2 3 4 5 6 7 8 9

P D Q Loss MC ATC AVC MR MR=MC 1 2 3 4 5 6 7 8 9 $200 $175 $150 $125 $100 $75 AVC $50 D $25 MR Q 1 2 3 4 5 6 7 8 9

Can a monopolist make a profit in the long-run? If the positions of a monopolist’s demand and cost curves give it a profit and nothing disturbs these curves, it can make a profit in the long-run

What is price discrimination? The practice of a seller charging different prices for the same product not justified by cost differences

What is arbitrage? The practice of earning a profit by buying a good at a low price and reselling the good at a higher price

Is price discrimination unfair? Many buyers benefit from the discrimination by not being excluded from purchasing the product

Is monopoly efficient? A monopolist is inefficient because resources are underallocated to the production of its product

Price Discrimination Market for average students MR=MC T1 MC D MR Q Q1

Price Discrimination Market for Superior Students Monopolist MR=MC Price Discrimination Market for Superior Students MC T2 D MR Q Q2

Is perfect competition efficient? A perfectly competitive firm that produces where P = MC achieves an efficient allocation of resources

P Perfect Competition MR=MC MC MR, D Pc Q Qc

P Monopolist MR=MC MC Pm D MR Q Qm

How does monopoly harm consumers? It charges a higher price and produces a lower quantity than would be the case in a perfectly competitive situation

Impact of Monopolizing and Industry MR=MC MC Pm Pc MR D Q Qm Qc

What is the case against monopoly? Higher price Charges a Price > MC Long-run economic profit Alters the distribution of income to favor monopolist

Key Concepts

Key Concepts What is a monopoly? What is a natural monopoly? What is unique about a natural monopoly? What is a price maker? What is the difference between monopoly and perfect competition? Why is MR < P for all but the first unit of output?

Key Concepts cont. Where does a monopolist produce to maximize profit or minimize losses? Can a monopolist make a profit in the long-run? What is price discrimination? How does monopoly harm consumers?

Summary

Monopoly is a single seller facing the entire industry demand curve because it is the industry. The monopolist sells a unique product, and extremely high barriers to entry protect it from competition.

Barriers to entry that prevent new firms from entering an industry are (1) ownership of an essential resource, (2) legal barriers, and (3) economies of scale. Government franchises, licenses, patents, and copyrights are the most obvious legal barriers to entry.

A natural monopoly arises because of of economies of scale in which the LRAC curve falls as production increases.

Without government restrictions, economies of scale allow a single firm to produce at a lower cost than any firm producing a smaller output. Thus, smaller firms leave the industry, new firms fear competing with the monopolist, and the result is that a monopoly emerges naturally.

Minimizing Costs in a Natural Monopoly Cost per Unit (dollars) 40 35 30 25 5 firms Cost per Unit (dollars) 20 2 firms 15 1 firm 10 5 Quantity of Output 100 20 40 60 80

A price-maker firm faces a downward-sloping demand curve A price-maker firm faces a downward-sloping demand curve. It therefore searches its demand curve to find the price-output combination that maximizes its profit and minimizes its loss.

The marginal revenue and the demand curves are downward-sloping for a monopolist. The marginal revenue curve for a monopolist is below the demand curve, the total revenue curve reaches its maximum where marginal revenue equals zero.

Price elasticity of demand corresponds to sections of the marginal revenue curve. When MR is positive, price elasticity of demand is elastic, Ed > 1. When MR is equal to zero, price elasticity of demand is unit elastic, = 1. When MR is negative, price elasticity of demand is inelastic, Ed < 1.

The short-run-profit-maximizing monopolist, like the perfectly competitive firm, locates the profit-maximizing price by producing the output where the MR and the MAC curves intersect. If this is less than the AVC curve, the monopolist shuts down to minimize losses.

P D Q Profit MC ATC AVC MR MR=MC 1 2 3 4 5 6 7 8 9 $200 $175 $150 $125 $100 Profit $75 AVC $50 D $25 MR Q 1 2 3 4 5 6 7 8 9

P D Q Loss MC ATC AVC MR MR=MC 1 2 3 4 5 6 7 8 9 $200 $175 $150 $125 $100 $75 AVC $50 D $25 MR Q 1 2 3 4 5 6 7 8 9

The long-run-profit-maximizing monopolist earns a profit because of barriers to entry. If demand and cost conditions prevent the monopolist from earning a profit, it will leave the industry.

Price discrimination allows the monopolist to increase profits by charging buyers different prices, rather than a single price.

Three conditions are necessary for price discrimination: (1) the demand curve must be downward-sloping, (2) buyers in different markets must have different price elasticities of demand, and (3) buyers must be prevented from reselling the product at a higher price than the purchase price.

Price Discrimination Market for average students MR=MC T1 MC D MR Q Q1

Price Discrimination Market for superior students Monopolist MR=MC MC T2 D MR Q Q2

Monopoly disadvantages are these: (1) A monopolist charges a higher price and produces less output than a perfectly competitive firm, (2) resource allocation is inefficient because the monopolist produces less than if competition existed, (3) monopoly produces higher long-run profits than if competition existed, and (4) monopoly transfers income from consumers to producers to a greater degree than under perfect competition.

P Perfect Competition MR=MC MC MR, D Pc Q Qc

P Monopolist MR=MC MC Pm D MR Q Qm

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